"Governments Don't Want to be Embarrassed" (w/ Matt Rowe & Jared Dillian)
MATT ROWE: And maybe that's a good segue way to talking about emerging from the coronavirus stall or coronavirus halt to the world's business. My contention is that once things reopen or things restart, it's not going to be a magic grand opening of an amusement park. It's more going to be like walking past the yellow tape of a crime scene and seeing just how bad it is on the inside. What do you think about where we go from here? What do you think people are going to be surprised by? Or what do you think is going to be the reaction to reopening the economy? JARED DILLIAN: Well, I think that we have the possibility to have a pretty deep 12- to 18-month recession. From a policy standpoint, I think we made it worse through unemployment benefits. We also did this in the financial crisis. We extended unemployment benefits to like 96 weeks or something like that. And there's a lot of research that shows that people don't look for work until their unemployment benefits are starting to run out. And in this particular case, we're paying unemployment benefits that are well in excess of what they were making at their jobs. So it's going to take a really, really long time to hire back those people. It's going to be a slow process. Yeah. I think we could have negative GDP out to the middle of 2021. MATT ROWE: And with that in mind-- here we go, me trying to get an investment angle out of this. With that in mind, how does anybody make sense of current valuation on stocks? I guess from my perspective, to the point of your article, you can be offended. You can be morally challenged with what the government is actually doing. But they're doing things. And our job as money managers is to take advantage of that and to make the best risk-adjusted decision we can. But I think about and I agree largely with what you said about the impairment on growth. But I also consider one of the greatest potentials for a positive equity market is a surprising level of growth. What do you think about equity valuations here? Or does it even matter? JARED DILLIAN: I think they're high. But I don't think it matters a lot. One of the things I learned very early in my career is that the stock market is not the economy, and the economy is not the stock market. And I think that statement is more true now than it ever has been in history. MATT ROWE: I agree with that. JARED DILLIAN: I think that in a Fed-free world, S&P would probably be below 2,000. And I think valuations would be a lot more reasonable, speaking of which, one of the things I wanted to mention was I wanted to talk a little bit about market commentary and how it pertains to this. Because getting back to the original point, people complaining about the Fed, there's a whole genre of financial commentary out there that talks about what the Fed should do. And instead we should be focused on what the Fed will do. And they have a very predictable reaction function. The government operates differently from the private sector. And I worked in the government, so I know this. The government is motivated by different things. They don't have P&L. What the government tries to do at all costs is to avoid being embarrassed. That is the Fed's reaction function. They act in a way so that they try to minimize embarrassment. And if you knew that going into this crisis, you knew that the most embarrassing thing that would have happened to the Fed is if they actually allowed the markets to fail at this particular point in time. So for the Fed buying credit, I think that was fairly easy to predict. And I think you could have made money off of that. MATT ROWE: Yeah. I think about it-- Powell is pretty transparent. And he has spoken about, in very direct terms, that the Fed's position is a short vol position, that they've effectively shorted puts to risk-takers across the market, and that the market has responded accordingly. And there's no reason to think that they're going to do anything different. So people have asked me, well, what do you think about the Fed's reaction, the Fed's action? Is it vol dampening? And the answer is absolutely. Most certainly it is. It doesn't mean that the jump to 0 probability for certain companies, to our earlier conversation, is removed entirely. It's not going to stem insolvency from certain companies. We're even today talking about hurts, potentially filing for bankruptcy and accessing that path. But I think you're right. I think it does. It lops off a significant bit of what I would refer to in the classic trinomial tree analysis of up node, down node, jump to 0. The jump to 0 for the market is effectively not there. It's funny when you're talking about the government, me being raised in a government household as well, that avoiding embarrassment at all costs-- maybe this is why the whole contention between or nasty relationship between the US Postal Service and Amazon exists because Amazon is killing it on doing this and effectively arbitraging the Postal Service right in front of a lot of people's face. And people don't like it. And maybe the biggest difference is retirement benefits and legacy liabilities. But that's a whole 'nother conversation. JARED DILLIAN: I think the best way to understand this-- a light bulb went off for me about a week ago. Somebody mentioned this to me in an email. I've been semi-unsuccessfully trying to short Canadian housing for the last 7 years. It's just been this ongoing saga. And I haven't gotten killed, but hasn't exactly been fun. MATT ROWE: So that's actually-- sorry to interrupt, though. That's amazing because number one, it's a hard thing to short. And number two, it sounds like you have some personal angle why you think that the valuations are ridiculous. What led you to wanting to enter into this? I'm just curious. JARED DILLIAN: Yeah. This was about 2013. And I started reading anecdotes about construction in Toronto and what was going on in Vancouver. And there's a lot of wiseguy US investors that said, OK, we just had a housing crash in the US. The same thing is going to happen in Canada. So this was a very popular short in the hedge fund community. And the thing that I literally just figured out last week is that culturally, Canada is the same with houses as we are with stocks in the US. In the US, we do not allow stocks to fail. It is in our DNA. We support the stock market. And in Canada, their savings are in houses. And the government cannot allow the housing market to fail. So just as pointless as it is to try to short housing in Canada, it's equally pointless to try to short stocks in the US. It's like a cultural thing. MATT ROWE: Yeah. Yeah. And I think you're right. Short alpha in the hedge fund world is something that is very hard to come by because you can be right academically, and you can be right theoretically. But if you don't get the timing perfect, the cost of financing a short or riding against the beta wave has largely made it impossible. It's like the rainbow unicorn to be able to generate short alpha consistently over time. One of the things that we were talking about before the interview on a phone conversation, too, coming back to the idea about General Motors and my experience with GM, I was personally offended by the fact that the US government threw out all bankruptcy precedent with General Motors coming out of '08. And it seemed to me that the reason they did that was because the VEBA at GM was effectively long General Motors stock. And they made a number of tactical errors and a number of managerial errors. But when the story was getting towards its conclusion, it seemed that the real crux of the problem was that General Motors had 250,000 pensioners that, without GM and the VEBA remaining intact, were going to become obligations of the US government. And so they opted to keep the company alive and to prop them up in ways that legal precedent wouldn't have dictated prior to that simply because it was cheaper and easier to keep the pensioners serviced, if you will, by the pension plan of GM. Do you see that system-wide right now, keeping companies intact and functioning supported by the government as a way of managing the population because it becomes a bigger problem if we get a series of failures? Or what do you think-- to your point of Americans loving the stock market like Canadians love housing, what do you think drives the desire to prop things up? JARED DILLIAN: Yeah. There's a whole lot to talk about there. I think we're there-- I think the parallel today with GM in 2008 is the airlines. And I think the airlines are going to have explicit government support for a long time. It's interesting because I was reading this morning that there's a whole bunch of retail investors that are piling into JETS, which is the airline ETF. Apparently Robinhood has gone from 300 accounts with JETS to 20,000 accounts with JETS in a week. And they've had like $480 million of assets go into that ETF. So people are trying to pick a bottom in airlines. I guess what I would say to that is the airlines are going to trade away a significant amount of upside in exchange for this support. And buying airlines at these valuations-- I mean, yeah, the airlines are not going to be allowed to fail. But all the upside is gone. All the upside is absolutely gone. And what happens in times of crisis is that people change the rules. People change the rules in times of crisis. And just like your experience with GM in 2008, this is what bankruptcy law says is supposed to happen. All the rules went out the window. We changed some other rules back then. We banned short selling of financials. So that's just what happens in times of crisis.